The Federal Reserve’s explanation for hiking rates on Wednesday did not mention Asia, but the region’s challenges were written between the lines in bold font.
Chairman Jerome Powell and his team pulled off their second tightening move of the year – by 25 basis points to 2% – and telegraphed at least two more in 2018. Yet as they pledge to heed “readings on financial and international developments” before acting again, it doesn’t require much imagination to discern who they’re watching.
Monetary austerity emanating from Washington is putting Asia’s current-account-deficit economies in harm’s way: Indonesia, the Philippines, India and others. Argentina, of course, is the economic problem child of the moment, blowing up anew. But that turmoil is heading east and creating control problems around this region.
And that is a good thing. Not in the short-run, of course. Well-known investors like Templeton’s Mark Mobius are talking contagion risks and Nobel laureates like Paul Krugman worry emerging markets face bigger threats than during the 2013 Fed “taper tantrum.” Perhaps. But the Fed’s determination to yank away the proverbial punchbowl is causing a spike in what might be called healthy paranoia in Asia.
Already, central-bank peers from Jakarta to New Delhi are beginning to tap on the brakes. Not to slow growth, but to cleanse systems of post-Lehman-Brothers-crash excesses. Their tightening moves are aimed at communicating to currency speculators that officials are safeguarding financial systems.
Fed’s discipline; Asia’s response
If not for the Fed, it’s doubtful Asia would be intensifying efforts to reverse current-account imbalances, strengthen national balance sheets and trim budget-busting subsidies. If not for Powell’s austerity, would the Philippines’ central bank be mulling macro-prudential tweaks to fix cracks in the economy?
And what of Mahathir Mohamad’s epic election upset in Malaysia? No, Powell and company did not drive disgraced former Prime Minister Najib Razak from power last month. The credit goes to voters rallying against Najib’s alleged corruption. But the ringgit’s dubious status as one of Asia’s worst-performers boomeranged back in Najib’s direction.
As Warren Buffett famously said: “It’s only when the tide goes out that markets see who’s swimming naked.” Voters finally realized that Najib’s economic policies had no clothes, ending his nine-year reign. The billions of dollars missing from 1Malaysia Development Bhd, the state fund Najib created in 2009, long turned off investors. But it was the Fed that led the move to accelerate the liquidity tide going out, knocking Malaysia Inc off balance.
That’s not to say Asia shouldn’t brace for a more aggressive Fed. Labor markets are drum-tight, inflation pressures are building and the massive $1.5 trillion tax cut engineered by President Donald Trump’s party is working its way through the economy. Still, the Fed is acting gradually and methodically to restore monetary normalcy to the biggest economy. That is partly to avoid touching off a global crisis that spins back in America’s direction.
Fed’s reach not restricted to US borders
Technically, the institution Powell runs has 12 districts. Over the last two decades, the most influential monetary power has added a few unofficial precincts. It’s hardly a reach to view Latin America as the 13th district, Southeast Asia the 14th, Russia the 15th and, perhaps, China as the 16th. Getting US rates as far away from zero as possible is a wise aspiration. But so is doing as little harm as possible to global stability.
Trump is another wildcard. His trade-war threats are one problem. His White House also expresses a desire for a weaker dollar – one in direct conflict with a central bank that is, in theory, independent. If Powell moves too quickly, he risks Trump attacking the Fed via Twitter.
Yet monetary punchbowls will be drained more and more. That is prodding Asian governments to focus more on domestic demand-led growth, less on exports. It’s nudging policymakers to address cracks and inefficiencies in financial systems. It is encouraging officials from Beijing to Hanoi to rein in asset bubbles and reduce vulnerabilities to any fresh turmoil.
Markets don’t always get things right, and neither does the Fed. But as Powell’s team ratchets up the pressure, governments will find markets merciless arbiters of who’s getting policies right and who’s wrong. The months ahead won’t be easy, but Asia’s longer-term trajectory will benefit from the heavy-lifting the Fed is forcing on the region.